Allocation of capital to private markets has increased hugely over the past few years. In 2022, it was over 24% higher than it was in 2021 and the consensus is that it will grow even further in the coming year (Source: Mandatewire, 31 December 2022).
For investors seeking private markets exposures private credit has many advantages, including strong cash flows and attractive returns. A large part of this lending activity takes place with companies in the “middle market” and although these companies are increasingly focusing on reducing the carbon emissions of their operations, it can be difficult for them to provide any information on their progress towards this aim. This is due, in part, to the limited resources.
While not necessarily reflective of a lack of progress, the challenges facing middle market companies in producing this data, particularly in comparison with their larger public counterparts, can be an issue for Local Government Pension Scheme (LGPS) private credit investors who may have their own decarbonisation targets, but for whom the profile of the asset class may otherwise meet their return targets.
During a recent industry webinar on Sustainable Private Credit, BlackRock’s Global Credit team shared our belief that with increased engagement and data measurement, private credit can help clients to meet both of these targets.
The mid-market problem
In order to achieve the Paris Agreement goals it is estimated that companies would need to reduce carbon emissions by c.55% by 2030 (Source: European Commission: 2030 Climate Target Plan, 29 March, 2023).
Large companies often have the luxury of dedicated resources focussed on setting net zero goals and an achievable plan to get there. The large multi-national companies are often under even more public scrutiny. Amazon and Nike, for example, have stated an aim to reach net zero across their supply chain by 2040 (Source: Amazon, The Climate Pledge, 31 March, 2023) (Source: Nike, What to Know About Nike's Stance on Tackling Climate Change, 19 September 2019).
Whether they can achieve this will depend, to at least some extent, on smaller, often start-up businesses, which are leading the development of ground-breaking new technologies designed to help large and medium-sized businesses reduce their emissions.
Because they are so numerous, middle market companies, which make up a significant part of private credit investment, contribute approximately 50% of global carbon emissions (Source: International Energy Agency, Accelerating Energy Efficiency in Small and Medium-sized Enterprises, 1 December 2015). A significant reduction in emissions by these companies may therefore have a considerable impact on the world’s transition towards a low-carbon future.
These companies want to set goals to reduce their carbon footprints, but they often do not know where to start or how to go about it.
Many middle market companies often do not have information on their own carbon emissions, which makes it hard for them to work out where to focus their efforts to reduce them.
Although the lack of transparency and data around decarbonisation in this space is a challenge, at BlackRock we also see it as an opportunity. This is where private lenders can work with these companies in their transition towards achieving a reduction in their carbon emissions, via knowledge sharing, introductions to third-party climate agencies and ongoing engagement, as some examples.
Digging into data
Historically, there has been less pressure across private markets than in other asset classes, for companies to disclose sustainability data in a transparent fashion.
That is partly because, unlike their larger public counterparts, they’re not required to do so for regulatory purposes and partly because the stakeholder pool for private companies is smaller than for larger public ones, with less pressure on disclosure from underlying stakeholders. This is changing, particularly in Europe, in response to regulation and client demand.
In our Private Credit business, we do this through our proprietary Environmental, Social and Governance (ESG) borrower questionnaire. This looks to cover a range of topics, including questions focussed on carbon emissions.
You can’t make progress on things you don’t measure, so to give our clients what they need, we must ensure that these businesses are acting on emissions and understand their strategy going forward.
